To understand Beats you need to understand Lady Gaga

Headphone sales? Music streaming service? Wearables? Music label deals? None of the current Beats products look as a credible reason for a deal of that size. Something much bigger is going on. It is not about what Beats is today, but about what Beats can become in the future.

To understand what Beats can become we need to understand Lady Gaga first. Lady-Gaga-the-business-model.

Lady Gaga broke in with her August 2008 debut album, “The Fame”, and became international megastar in few short years. Gaga won Billboard magazine’s Artists of the Year title 2010, is ranked fourth in VH1's list of 100 Greatest Women in Music, is the fourth best selling digital singles artist in US according to RIAA, is on Forbes magazine The World’s 100 Most Powerful Women list from 2010 to 2013, and was named one of the most influential people in the world by Time magazine.

Lady Gaga was the subject of numerous business case studies, including by Harvard Business Review (Anita Elberse, Michael Christensen) and Business Strategy Review (Jamie Anderson, Jörg Reckhenrich and Martin Kupp). What makes Lady Gaga special is pioneering use of social media to build a loyal community of fans to “sell the artist” in what music industry calls “360 deal”. The “360 deal” is reminiscent of a VC investment model where a label invests more money up front in exchange for a piece of merchandise sales, touring revenue and other earnings that artists had long kept for themselves.

Beats by Dr. Dre selling branded Heart Beats model of the $100 in-ear headphones as “undeniably unique” and likely to “attract fashionistas far and wide.” (The story is much bigger here than this specific deal.)

Virgin Mobile sponsoring the U.S. tour dates of the Monster Ball tour.

Polaroid, which appointed Lady Gaga as creative director for a special line of products that would be released in the coming years.

In 2011, Amazon launched a promotional campaign selling at a loss Lady Gaga’s album “Born This Way”, essentially subsidizing distribution of the new album.

In an interview with The Wall Street Journal, Gaga was asked whether she believed that “Born This Way” was worth more than 99 cents. The answer is very telling:

“No. I absolutely do not, especially for MP3s and digital music. It’s invisible. It’s in space. If anything, I applaud a company like Amazon for equating the value of digital versus the physical copy, and giving the opportunity to everyone to buy music,” she said. “It also wasn’t really 99 cents, because Amazon paid the difference on all of those purchases as part of their promotional campaign for one of their new services. I think it’s amazing and it was a really nice surprise and I felt honored that they chose my record to be part of it.”

Troy Carter, who discovered Gaga and was her manager till November 2013 being widely credited for much of her business strategy sums it up nicely in his interview to FastCompany:

“It was more about building a platform on top of music—because music, we realized, sells everything but music.”

(Note that Mike accurately predicted the rise of the new business models in music well before Gaga’s business success became known.)

Digital music is abundant (“It’s invisible. It’s in space” as Gaga puts it) and music industry whose business models were rooted in scarcity of vinyl records and later CDs were turned upside down by the need to deal with abundance of digital music. The good news, Mike says, is that for every abundance new scarcity is created. Gaga-the-business-model is an excellent example of how to benefit from these new scarcities created by the transition to digital.

The business people behind Gaga also saw the missing link in the digital music value chain. This missing link is also a huge opportunity to fill the void going much further than “selling the artist” to the loyal fan base.

In February 2013 Jimmy Iovine, Chairman of Interscope Records (Lady Gaga’s record company) and at the same time co-founder and CEO of Beats, gave very revealing interview to D:Dive Into Media. The most interesting bit comes in the Q&A section where Jimmy divulges his vision for BeatsMusic.com 35 min 15 sec in the interview (and it’s not about curation):

“But there something else going on our service that doesn’t go on anywhere. We have to make it user-friendly to the artist. They have to be able to build businesses on it. They have to be able to have the information who is using their music, where they are… That has to become a business for the artist as much as communicating with their fans. Right now, they (music services) have all the information and the artist have no information. No one knows… I don’t know. I own a record company. I would die to know who bought my records on iTunes or bought my tickets on TicketMaster.”

Jimmy Iovine sees the opportunity in changing the game and “building a communication between a fan and an artist.” In other words Beats Music is not yet another streaming service designed to sell music, but a platform for artists to build businesses and “sell everything but music” as Troy Carter says.

In essence, Beats aims to become Uber of music by aggregating demand, connecting listeners to artists and empowering the artists to build thriving business on top of the platform. Much like Uber, which promises to end the era of poorly paid cab drivers. Or like Apple App Store, which connects users with app developers allowing them to build business on top of the platform.

Pandora, Spotify, Play Music and Amazon that are all designed to sell music, will have very hard time to compete against a platform for building businesses on top of music. As Marshall Van Alstyne said in slightly underestimated way (pun intended):

“There is a strong argument that platforms beat products every time.”

The acquisition makes very good sense for both Apple and Beats. Beats gets the opportunity to kickstart network effects of the platform by bringing huge base of Apple users together with their credit cards to artists. Apple at the same time will benefit by bundling the music platform with its iDevices, where the company makes most of its profits and badly needs to rejuvenate growth.

(I don’t think Apple will prevent BeatsMusic service from being available on Android devices. Having best experience with most fresh music reserved for Apple users will do just fine. “Apple-first” strategy works very well for both most mobile app developers and Apple.)

Interesting times ahead — As Troy Carter says in his interview to Guardian:

“Hollywood, record labels and tech giants such as Apple, Google and Samsung face immense risks and opportunities. Everybody should be afraid right now. We saw what happened to Nokia and BlackBerry and Motorola. Nobody saw Android coming. Nobody saw the iPhone coming. Nobody saw Samsung coming. No one is safe right now. Everything is moving so quickly.”

Music industry need to brace for deep and painful disruption, much like legacy taxi cartels and unions across the globe. Samsung needs to find new source for differentiation after acknowledging defeat with its home-grown music service. Will health and wearables fill this void? Google will probably scramble to build a competitor to Apple/Beats refocusing YouTube Music from labels to artists. Amazon will need to find a solution if the company wants to stay relevant in the music distribution on which it relies for promotion.

“Obviously, we can’t talk about that, as you know. See, in the record business, you can show someone your song, and they don’t copy it. In the tech business, you show somebody your idea, and they steal it.”

The strategy lesson from Apple and Beats is this: Look for opportunities to build platforms connecting consumers with value-adding complementors. (Think a “connect-ing business”, and not a “connected business”.) Capture value through bundling with the platform that will buy you hyper-growth driven by network effects and insurmountable competitive advantage. (And of course don’t tell anybody what’s you are up to before it’s ready.)